FCFE & DDM

[ClayParks]

There is probably an easy explanation here but there isn’t one that comes to mind yet…
Q: When FCFE is greater than dividends, the value obtained using FCFE will equal the value obtained using DDM if:
A: excess cash is invested in projects with a NPV of zero
I can’t argue with it because I can’t think of why this is true or false…any help would be appreciated.

 

[gulfcfa]

Think of it in terms of residual income model…
What creates value? Value is created when you take money and you earn a return that exceeds what you should be earning…
Well if you are taking those extra cash flows and simply earning what you should be earning. You are not creating any additional value…

 

[AndrewUNH]

No gulf, YOU are not creating any additional value
gulfcfa Wrote:
——————————————————-
> Think of it in terms of residual income model…
>
> What creates value? Value is created when you take
> money and you earn a return that exceeds what you
> should be earning…
>
> Well if you are taking those extra cash flows and
> simply earning what you should be earning. You are
> not creating any additional value…

 

[ClayParks]

that makes sense…
If I have additional cash flow that is not paid to shareholders and it is reinvested back into the firm the hope is that management has the ability to invest in projects that will add value (positive NPV). If management choses a project that ends up having a NPV of zero then the return is equal to the cost of capital (cost of capital=IRR)…if no value is added by retained earnings the DDM and FCFE models should result in the same answer.